Kerry's Battle Plan

He can't simply rely on anti-Bush fervor to get elected. So he's out to ease the middle-class squeeze

August 2, 2004, 12:00 AM EDT

After a Lazarus-like revival from the back of the primary pack, the lanky Massachusetts senator has repeatedly surprised political sages. Kerry overcame a ponderous campaign style to unite his party, helped Dems shatter fund-raising records, and has pulled ahead of a wartime President despite a growing economy.

Yet as he preps for his July 29 star turn, Kerry realizes that even a studiously centrist convention will still leave him a long way from his goal of the Presidency. Despite discontent with George W. Bush, a large swath of America feels it doesn't know enough about Kerry, his heart, or his soul to consider him as an alternative -- yet. And much of what voters do know isn't flattering, thanks in part to a GOP ad blitz. In a July 10-13 poll by the liberal Democracy Corps, 60% thought Kerry would raise their taxes despite his pledge to limit the bite to the wealthy; 51% considered him too liberal.

Kerry needs to change such attitudes, starting with a makeover in Boston. But with the White House accelerating the military disengagement in Iraq, he also knows he can no longer count on voter disillusionment with the troubled U.S. occupation to clinch the election. So as attention shifts back to the economy, Kerry has renewed his emphasis on jobs and the "middle-class squeeze."

His agenda -- a set of programs aimed at helping workers cope with rising health and tuition costs, the offshoring of jobs, and stagnant wages -- is complex and pricey. It's also a sketchy blueprint that, should Kerry win the election, will almost certainly undergo radical surgery when the candidate confronts budget reality and what's likely to be a hostile GOP Congress. At its core is a grand bargain: Kerry offers a $650 billion health-insurance plan and $200 billion in education spending, to be financed by rolling back Bush's tax cuts for families earning more than $200,000 -- about 3% of taxpayers. That could free up some $600 billion to $860 billion -- money the Dems feel could be better used to ease stress on working families and spur consumption.

But that would leave nothing for Kerry's pledge to slash the deficit. And if a GOP-controlled Congress balks at rolling back tax breaks for the wealthy, he would have to drastically scale down his ambitions, risking the ire of voters. Other potential problems: In addition to stripping the well-heeled of their top tax rate, Kerrynomics would hike their taxes on capital gains and dividends. Kerry sees this as a matter of fairness. But some economists worry that such moves could harm investor psychology and capital formation. "Cutting dividend taxes was the single most important thing Republicans did under Bush," says American Enterprise Institute economist Kevin A. Hassett. James C. Tyree, CEO of Mesirow Financial Holdings Inc., a Chicago money manager, backs most of Kerry's tax ideas, but says: "For future growth, the capital-gains cut is critical."

FORMULA FOR GROWTH

Kerry, however, believes tilting away from the rich -- who have more propensity to save than average workers -- and redirecting money toward "human capital" is a better formula for growth. "If we're going to be competitive in the global economy, we've got to dig out of our fiscal hole, fix health care, and have a more effective public education system," says former Treasury Secretary Robert E. Rubin, a Kerry confidante. "If Kerry gets elected, he'd be terrific on these issues."

Yet an expansive new middle-class safety net would come at the cost of higher taxes on affluent investors. While Kerry insists that hitting up the rich to help the middle class is worthwhile, many economists fear it will harm long-term growth. "Raising taxes would have a decidedly negative effect on the economy," says Mickey D. Levy, chief economist at Bank of America Corp.

Few economists have put pencils to Kerrynomics' overall impact. One of the first studies, a forthcoming paper by forecasters Economy.com in West Chester, Pa., finds that diverting wealthy taxpayers' cuts to health care would boost growth slightly -- by up to a quarter of a percentage point -- in the first four years. But then, Kerry falls far short of his pledge to trim the deficit, and higher interest rates crimp growth after 2009. "The boost only works in the short term," says Mark M. Zandi, the firm's chief economist.

As Kerry has climbed in the polls, business anxiety has deepened. "Kerry has a good chance in the fall -- but he has always had an anti-business voting record," frets Peter McCausland, CEO of Airgas Inc., a Radnor (Pa.) industrial company. Adds Edward M. Liddy, CEO of Allstate Corp. in Northbrook, Ill.: "If he wants to increase taxes, I think that's bad for the economy." But Kerrynomics is more complex than GOP caricatures, and Kerry's challenge now is to explain it to voters in a way they can quickly grasp. Among the key elements:

KERRYCARE The Democrat's top priority is a plan to expand health coverage while driving down premiums -- not an easy feat. Kerry would extend government insurance for children and low-income workers. Small businesses that can't currently afford care could join a national pool to cover their employees. For all employers, the feds would take over the cost of catastrophic illness. Finally, Doc Kerry would use new technology to slash overhead and waste.

Some conservative economists applaud Kerry's decision to build on the employer-based system. But they fear that the government, in a giant shuffle, would be taking on a huge commitment without doing much to control costs.

KERRYKIDS Kerry wants to spend $200 billion over 10 years to bolster public schools, hike teacher salaries, and offer tuition help for families. His College Opportunity Tax Credit provides a $2,500-a-year break to help pay for college. He vows to spend $100 billion to fully fund Bush's No Child Left Behind Act, a law that mandated tough standards but, critics charge, didn't provide enough cash. "Kerry's higher-education platform is critical," declares Chris Gabrieli, a Massachusetts venture capitalist. "For the first time, we are seeing a widening [income] gap on college accessibility."

But Kerry's education plans are under fire from both the Right and the Left. Republicans suspect that, in exchange for grassroots support, he will reward teachers' unions by watering down standards. "We need to stay the course on accountability," says Susan Traiman, an education expert at the Business Roundtable. "Resources alone won't fix schools." Others worry that Kerry shortchanges preschool programs and aid for poor children. "Middle-class programs are obviously more popular politically," notes Isabel V. Sawhill, a Brookings Institution economist. "But if kids fall behind early, they'll never catch up."

JOBS As the first U.S. leader since Herbert Hoover to preside over a net job loss during his term, Bush is vulnerable to charges that his policies have hurt working Americans. To spur job creation, Kerry proposes a tax credit for new hiring by manufacturers, small business, and companies affected by outsourcing. And he would end capital-gains taxes for investments held for five years or longer by some small businesses. But the record of targeted tax incentives is spotty. In practice, most of the cash ends up subsidizing jobs that would have been created anyway.

Kerry is also trying to slow the export of U.S. jobs to low-wage countries. He would end favored tax treatment of profits earned overseas by U.S. multinationals in an effort to encourage more outfits to locate in the U.S. That may sound unrealistic in a global economy, but Kerry offers two goodies to tilt the table. To entice companies to bring home profits earned abroad, he dangles a one-time reduced 5% tax on repatriated earnings. And he promises to cut the top tax rate for all corporations from the current 35% to 33.5%.

Kerry presided over a hot internal debate over this issue. More liberal aides eyeing funds for social programs objected to a business tax cut, but Kerry felt it was a smart symbolic move. "When was the last time a Democrat proposed cutting corporate taxes?" says top Kerry strategist Bob Shrum. "People like Ted Kennedy were saying: 'John, what are you doing?"'

If the gambit was supposed to please business, it flopped. Groups such the National Association of Manufacturers blast Kerry for hurting multinationals that already face stiff competition. "Kerry's proposal on foreign-source profits is upside down," says Dirk Van Dongen, president of the National Association of Wholesaler-Distributors. "It rewards high-cost companies." Adds Jon A. Boscia, CEO of Lincoln Financial Group in Philadelphia: "We have to walk a fine line between protecting jobs and impeding capital flows."

TRADE Business is agonizing over Kerry's "fair trade" policy -- especially since he put North Carolina's John Edwards on the ticket. In the Senate, Kerry was a free-trader but now vows to fight "unfair" foreign competition. He would slap a moratorium on new trade pacts pending a 120-day policy review. He leans toward labor's call to reopen the WTO and NAFTA pacts to toughen worker and environmental protections. And he claims he'll confront Beijing over currency manipulation, intellectual property theft, and dumping.

Amending NAFTA is largely symbolic, however, because enforcement of labor standards is virtually nonexistent in many developing countries. Bill Clinton engaged in a similar rhetorical exercise -- then proved his free-trade credentials by pushing trade pacts through Congress.

Kerry, in contrast, is a question mark, and could easily rile China with a raft of trade complaints. Scott Kriens, CEO of Juniper Networks Inc. (JNPR
) in Sunnyvale, Calif., worries that under Kerry and Edwards, the U.S. could "become isolationist and ignore global forces."

THE DEFICIT Kerry thinks a credible plan to lower deficits will put downward pressure on interest rates and reduce stress on capital markets. And he vows to lead by example. In a July 16 talk with BusinessWeek, he said: "I am absolutely committed" to deficit-fighting and pledged to trim his plans if he comes up short of funds. "Kerry will restore the policies that brought prosperity in the '90s," says adviser Roger C. Altman, chairman of New York investment bank Evercore Partners.

How? Kerry vows to bring back pay-as-you-go rules and spending caps that Congress let lapse. And he has already scaled back his aid to states and education in response to GOP ads that claimed he would have to raise taxes by $1 trillion to pay for his agenda. Like Bush, he pledges to cut the deficit in half by 2008. But also like Bush, his plan to do that is nebulous. "At best, this is a treading-water scenario," says Robert L. Bixby, executive director of the Concord Coalition, a budget-watchdog group.

Since neither candidate is showing much appetite for a fight to control entitlements, Kerry and Bush must spin gossamer dreams of another market boom -- and with it, a revenue-gusher that lifts all boats. "I believe we can have a tech boom again," Kerry insists.

But will we see a reprise of the Roaring Nineties? The huge corporate investment in info tech that underpinned the boom may be behind us. What's more, with defense spending rising, sopping up the red ink will be harder than usual. "The most striking thing about Kerry's agenda is that it's not Rubinomics," says Andy Laperriere, managing director of International Strategy & Investment Group Inc., an institutional broker. "He's claiming Rubinomics without having a plan."

Kerryites reply that they would be fools to roll out detailed budget cuts in the midst of a campaign. Still, supporters believe he'll deliver -- if only to pacify the markets. Says media mogul Barry Diller, CEO of IAC/InterActiveCorp. (IACI
): "I have known Kerry for 20 years, and I don't think he will run an Administration that is anything but centrist."

A cautious pol by nature, Kerry is unlikely to launch a spending spree. But investors rattled by talk of hiking top-bracket taxes on capital gains and dividends still worry that he might yank some spark plugs of growth. A new study by University of California at Berkeley economists Emmanuel Saez and Raj Chetty found that dividend payouts rose sharply after the 2003 tax cut. And Zandi calculates that Bush's cap gains and dividend cuts fattened stock prices by 5%.

Yet there's little hard evidence so far that Bush's investment tax cuts boosted capital spending or economic growth. So Dems insist repeal won't be a downer. "There is no established link between capital-gains tax cuts and growth," says Kerry supporter Laura D. Tyson, dean of the London Business School and a BusinessWeek columnist.

The bottom line on Kerrynomics? If elected, Kerry would put most of his limited chits on a bruising battle to swap top-bracket tax hikes for better health care. Other initiatives would fall by the wayside if a GOP Congress balks. On protectionism, Kerry-watchers wager that his bark is worse than his bite. And many budget experts suspect that given his domestic ambitions, he'll do more to shift the composition of federal spending than to trim it with an aggressive war on waste.

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The result could be a standoff in which Republicans act as a check on Kerry's middle-class dreams. "Wall Street is beginning to think that this guy might win," says Gregory R. Valliere, managing director of Schwab Washington Research Group. But is there panic at the intersection of Wall and Broad Streets? Hardly. "If he wins, we will have gridlock. That's not bad at all for markets," says Valliere.

Kerry isn't fazed by such predictions. He vows to rally voters, Arnold Schwarzenegger-style, to sweep out Republican obstructionists. "If these people resist, I'll go to the country, and we will have that fight in the midterm elections," Kerry vows. "That's what leadership is about." John Kerry as political Terminator? Stranger things have happened.